KRA Zero-Rated vs VAT Exempt: What Every Kenyan Business Should Know About the Finance Bill 2026

“Stephen, I keep hearing that some items have moved from zero-rated to VAT exempt under the Finance Bill 2026. Aren’t they the same thing?”

That was a question a friend asked me recently. Like many business owners, he assumed that if VAT is not charged, then there is no difference between zero-rated and exempt supplies.

In reality, the distinction is significant and can have a direct impact on business costs, cash flow, profitability, and VAT refunds.

Under Kenya’s VAT framework, as guided by the Value Added Tax Act, 2013 (Revised 2024), there are two key categories of supplies that are not subject to VAT in the same way as standard-rated items:

Understanding Zero-Rated Supplies

A zero-rated supply is a taxable supply that attracts VAT at 0%.

Although no VAT is charged to the customer, the supplier remains entitled to claim input VAT incurred on purchases related to making those supplies.

For example, if a manufacturer purchases raw materials and incurs VAT of KSh 100,000 while producing a zero-rated product, the manufacturer can claim or recover that VAT from KRA.

In simple terms:

• Output VAT = 0%
• Input VAT = Recoverable

Understanding VAT Exempt Supplies

VAT-exempt supplies are not taxable supplies for VAT purposes.

A supplier of exempt goods or services does not charge VAT to customers and cannot recover input VAT incurred on purchases related to those supplies.

Using the same example above, if the product becomes VAT exempt, the KSh 100,000 VAT incurred on purchases becomes a cost to the business.

In simple terms:

• Output VAT = Not charged
• Input VAT = Not recoverable

The Key Difference

The biggest distinction lies in the treatment of input VAT.

A business making zero-rated supplies can recover VAT incurred on purchases, while a business making exempt supplies generally absorbs that VAT as an additional cost – This is why tax professionals often say, “Zero-rated is better than exempt.”

What Is Changing Under the Finance Bill 2026?

The Finance Bill 2026 proposes several changes to the VAT regime by moving certain supplies between the zero-rated, exempt, and standard-rated categories. The intention is to broaden the tax base, improve compliance, and simplify administration.

Among the notable proposals are:

• Some supplies previously enjoying favourable VAT treatment are proposed to move to the exempt category.
• Affordable housing-related supplies are proposed to move from zero-rated status to VAT-exempt status.
• Certain goods and services are proposed to be added to the exempt schedule, including selected healthcare, agricultural, infrastructure, and telecommunications items.

The proposed changes are expected to take effect from 1 July 2026 if enacted by Parliament.

What Are the Implications for Businesses?

1. Increased Cost of Doing Business

Where a supply moves from zero-rated to exempt, businesses lose the right to claim input VAT. This VAT becomes part of the cost structure and may reduce profit margins.

2. Higher Consumer Prices

Businesses may pass the additional VAT costs to consumers through higher selling prices.

3. Reduced VAT Refund Claims

Businesses dealing in zero-rated supplies often generate VAT refund claims. Moving supplies to exempt status reduces refund opportunities and improves government cash collections.

4. Need for Tax Planning

Businesses will need to reassess pricing models, budgets, contracts, and cash flow projections to accommodate the new VAT treatment.

Conclusion

While both zero-rated and VAT-exempt supplies may appear similar because no VAT is ultimately charged to the customer, the difference is substantial from a business perspective. A move from zero-rated to exempt status may seem like a minor legislative amendment, but it can significantly increase operating costs by denying businesses the right to recover input VAT.

As Parliament continues debating the Finance Bill 2026, business owners should carefully review how the proposed VAT changes affect their industries and seek professional tax advice where necessary. My advice is simple: do not focus only on whether VAT is charged to your customer. Focus on whether you can recover the VAT you incur. That is where the real financial impact lies.